3 Cost Behaviour Flashcards
What are the four kinds of cost behaviours?
- Variable Cost
- Fixed Cost
- Stepped Fixed Cost
- Semi Variable Cost
What is a variable cost?
This is a cost which tends to vary in total with the level of activity. More that is produced, the higher the total cost.
Examples - direct costs, machine running costs (look at graphs on page 19)
What is a fixed cost?
This is a cost incurred for a period and within certain output and turnover limits => unaffected by fluctuations in the levels of activity. May be fixed in the short term but variable in the long term.
Examples = rent, rates (look at graph on page 20)
What are stepped fixed costs?
Cost fixed for a particular range of activity levels, once upper limit of that range is passed => new higher level of fixed cost incurred
- Short term likely to be treated as a fixed cost, over longer timescales it is more likely to be considered as a VC. E.g. rent tends to be a FC in short-term but in longer term there is potential to re-negociate amount of space needed
What are Semi-Variable costs?
Costs containing both a fixed and variable component and thus affected by fluctuations in the level of activity.
- Examples include: Electricity cost, telephone bill
(look at graphs on page 21)
- Normally TC is similar to the semi-variable cost.
What is the high-low method?
- Method for estimating cost behaviour by comparing the total costs associated with two different levels of output. Difference in costs in assumed to be caused by VC’s increasing, allowing unit VC to be calculated => total FC can also then be calculated.
How do you work out the variable cost per unit?
VC per unit = change in total costs/ change in output
What are the advantages and disadvantages of the high-low method?
Ads:
- Simple to calculate and explain
- Only requires two pieces of data
Disads:
1. Data points used are by definition extreme points and may not be representative of the standard cost behaviour in between
With regression analysis what are the steps involved for the line of best fit method?
Step 1: Plot graph of say, costs and output levels
Step 2: Draw line of best fit through the points
Step 3: Estimate the fixed cost as the point at which the line cuts the ‘y’ axis (vertical)
Step 4: Estimate the VC per unit by using one of the other points that is fairly close to the line as a guide.
What are the ads and disads of the line of best fit method?
Ads:
1. Takes all the observations into account
Disads:
- Uses historic data, may not be a good guide for the future
- Estimate, which may be inaccurate
- Assumes that output/activity solely determines cost
What is a positive and negative correlation?
Positive correlation = x and y change together in the same direction
Negative correlation = x and y change together, but in the opposite directions
What is the correlation coefficient (r)?
- Indicates strength of relationship between variables
- Will always be between -1 and +1 (indicates gradient of line)
- If closer to 1 then line of best fit is closer to actual variables
What is the coefficient of determination (r2)?
- Indicates the proportion of change in the y (dependent) variable which is explained by change in the x (independent) variable.
- Will always be between 0 and +1
- If r2 = 0.915849 => 91.5849% of the change of total cost is explained by the change in the output.
What are the ads and disads of regression analysis?
Ads:
- Takes all pairs of data into consideration unlike the high/low method that just uses two
- Gives statistically accurate link between the two variables
Disads:
- Relies on historical data, which may not be accurate guide for the future
- Assumes there is a linear relationship between the two variables
- May suggest a cause and effect relationship where in fact there isn’t one
- Dependent variable may be affected by many variables, not just one
- Should only be used over the range of data supplied
